Big companies are increasingly tying executive pay to climate performance. Is it enough to make a difference?
Along with the boom in environmental, social, governance (ESG) investing, a growing number of Canadian companies are also tying executive compensation to performance on climate targets.
It’s a simple, yet powerful idea: if a company underperforms on its emissions targets, executives receive less pay. However, if companies choose unambitious metrics to evaluate executive performance, climate-linked compensation risks being reduced to a box-ticking exercise that does not incentivize better performance.
As more companies begin connecting executive pay to climate progress, it is worth briefly noting when this can be effective (and when it isn’t).
Over half of the TSX60 tie executive pay to climate performance
The good news is that more big companies are paying their executives based in part on their climate performance. Today, more than half the companies on the TSX60 (the index of Canada’s top 60 largest corporations) do so, compared to just nine companies that had a link to sustainability and executive pay in 2019.
In our recent updates to the 440 Corporate Climate Commitment tracker, we’ve tracked the number of companies in the TSX60 that have linked their climate goals to executive pay. The tracker also indicates whether companies disclosed any specific metrics they use to assess executive performance.
In 2022, the number of TSX60 companies with climate-related compensation increased to 39, up from 29 in 2021 (Figure 1). Part of the growth is linked to the larger number of companies that are establishing emissions reduction targets. In 2022, a total of 40 TSX60 companies (up from 35 in 2021) committed to reach net zero emissions by 2050.
This signals that a sizable share of Canadian companies are using executive compensation as a governance mechanism to align their management with climate goals.
Performance pay only works when incentives are strong
While more companies are tying their executive compensation to climate targets, how companies measure and reward performance matters much more. Transparency overall remains an issue, particularly in two areas (Figure 2):
First, we need to know what metrics are used to evaluate performance. Useful metrics could include the absolute emissions of the company or metrics that track reductions in the emissions intensity of a product.
Currently, out of the 39 companies within the TSX60 that link climate performance with pay, only 18 have published explicit emissions reduction metrics that they use to evaluate executive compensation. More than half of the companies on the TSX60 do not give any indication of the specific metrics they use to tie performance to climate; their statements only indicate that some undisclosed climate-related measures are considered when determining executive compensation.
Second, tracking the effectiveness of climate-linked compensation is also about understanding the weight of metrics used. Weight matters because it determines how salient financial incentives can be to improve performance performance. While the bulk of executive compensation will likely remain tied to financial metrics, if the weight of climate metrics is too small, so is the incentive to perform.
Currently, only 12 of the TSX60 companies have actually disclosed the weight of their climate metrics. These weights range between 3.6 to 12 per cent, and are typically found in short-term incentive plans that are used to assess compensation for annual incentives such as annual bonuses.
Lastly, it is worth noting that over two-thirds (27 out of 39) of the companies have tied executive compensation to the broader umbrella of environment, social, and governance (ESG) goals. While this highlights the overall commitment by companies to address a range of non-financial performance, this practice often also makes it difficult to discern the exact metrics and weights of each sub-category if they aren’t broken down.
Overall, we can see that over half of Canada’s largest companies with climate-linked executive pay can more transparently show how they decide and award compensation. Without more information, it is difficult to discern whether the proper elements of effective climate-linked executive compensation are in place: The metrics used to evaluate climate performance and the financial incentives in place both need to be ambitious enough to align executive performance with a company’s broader climate goals.
Arthur Zhang is a Research Associate with the Canadian Climate Institute.